Good day, and welcome to the Bel Fuse Inc. Fourth Quarter and Fiscal Year 2019 Conference Call. Today's conference is being recorded. At this time, I would like to turn the call over to Dan Bernstein, President and Chief Executive Officer. Please go ahead.

Thank you, Sanna. Joining me on the call today is Craig Brosious, our Vice President of Finance; and Lynn Hutkin, our Director of Financial Reporting. Before we begin the call, I'd like to ask Lynn to go over the safe harbor statement. Lynn?

Thank you, Dan. Good morning, everybody. Before we start, I'd like to read the following safe harbor statement. Except for historical information contained on this call, the matters discussed on this call, such as statements regarding potential sales growth; the anticipated impact of the acquisition of the power assets of CUI, Inc. on Bel sales and EBITDA margin; anticipated cost savings resulting from Bel's global cost structure initiatives; the timing of completion of Bel's ERP implementation; the expected effects of streamlining on Bel's overall profitability; the anticipated impact of the coronavirus outbreak; the extended Lunar New Year holiday break; and the grounding of Boeing 737 MAX; productivity levels at Bel's four manufacturing sites in China; Bel's ability to adjust workload levels at the China site; and an increase in airline maintenance spend on existing aircraft, are forward-looking statements as described under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Actual results could differ materially from those projections. Among the factors that could cause actual results to differ materially from such statements are: the market concerns facing our customers; the continuing viability of sectors that rely on our products; the effects of business and economic conditions; the success of efforts to contain and otherwise respond to the coronavirus; difficulties associated with integrating recently acquired companies; capacity and supply constraints or difficulties; product development, commercialization or technological difficulties; the regulatory and trade environment; risks associated with foreign currencies; uncertainties associated with legal proceedings; the market's acceptance of the company's new products and competitive responses to those new products; the impact of changes to U.S. trade and tariff policies; and the risk factors detailed from time-to-time in the company's SEC reports. In light of the risks and uncertainties, there can be no assurance that any forward-looking statement will in fact prove to be correct. We undertake no obligation to update or revise any forward-looking statements. We also may discuss non-GAAP results during this call, and reconciliations of our GAAP results to non-GAAP results have been included in our release. I would now like to turn the call back to Dan for a general business update.

Thank you, Lynn. Before going through the financials, I would like to provide a brief update on how the business did from the operations standpoint this quarter and what we see going forward. The fourth quarter continued to be challenging for us as our customers and distributors work through the excess inventory on hand. Further, the ongoing tariffs have resulted in certain customers finding alternate sources for their product, which impacted our sales in the fourth quarter. In addition, material costs remain high through the end of this year, putting additional pressure on our margins. By the year-end, we've seen an indication of customer inventory levels coming down, and bookings for our cinch and magnetic product groups have started to improve. During the fourth quarter, we closed our office in Shanghai and implemented other indirect headcount reductions in Asia. Overall 2019, a total of $5.7 million of annualized cost savings were implemented. Of this amount, $1.7 million were realized in the second half of 2019, and the incremental $4 million will be realized in 2020. In December, we closed on our acquisition of CUI Power Assets. We are pleased with the results – we have been pleased with the results of this acquisition so far. On Friday, February 14, we filed our 8-K with all the financial and pro forma relating to this acquisition. Historically, the gross margins of this acquired business were approximately 40% with an EBITDA margin of 10%, in down sales years. We look-forward to a full year of contribution from the business in 2020. From what we see today, the first quarter will be very difficult, given the challenges around coronavirus and the grounding of the Boeing 737 MAX. Bel is closely monitoring the coronavirus outbreak and its impact on our operations and supply channels. We…

Thanks, Dan. Before going through the numbers, I want to point out a few changes in our financial statement presentation and reporting disclosures that were implemented during the fourth quarter of 2019. As noted on last quarter's call, our research and development costs were historically included as a component of cost of sales and were therefore a factor in arriving at gross profit. This classification is different than the majority of our peers. Financial statements included in today's earnings release reflect the reclassification of R&D expense outside of cost of sales and is shown as a separate line before gross profit. Prior periods have been recast to reflect this revised presentation. Similarly, foreign exchange gains and losses, which were historically included in our SG&A expense, have been reclassified to the other income and expense line in all periods presented. This change in presentation is also done to conform with the presentation of our peers to measuring profitability for our investors. It also provides better transparency of the SG&A expense related to our day-to-day operations. Lastly, we implemented a change to our reportable segments during the fourth quarter. In the past, our reportable operating segments were geographic in nature: North America, Europe and Asia. In connection with our migration to the new ERP system and with the acquisition of CUI, we are now looking at the business on a product group basis and making decisions based on the profitability of our three product segments: Connectivity Solutions; Power Solutions and Protection; and Magnetic Solutions. Profit measures for our three product segments will be included in our upcoming 2019 10-K filing. Moving on to the financials, sales of our product segment for the fourth quarter of 2019 were as follows: Connectivity Solutions sales were $41 million, a decline of 12% from last year's…

Thank you, Craig. At this time, we would like to open up the call for any questions that you might have.

[Operator Instructions] We will now take our first question from Theodore O'Neill from Litchfield Hills Research. Please go ahead. O’Neil, your line is…

Sorry, I was mute here. So I understand there are a number of macroeconomic headwinds here. But were there any bright spots in the quarter or that you see in the upcoming quarter?

I see in the first quarter, military aerospace. We do see some improved bookings on the magnetic product side. Our bookings have improved slightly. However, we do think, because lead times are going to be stretched out because of the situation in China, that more people will be putting orders in books. So again, we do think that the first quarter will be weaker than we perceive. But hopefully, things get a lot stronger in the second quarter and going forward.

And is there anything you could do in the near term to deal with the customer sourcing products from other than China?

We have been looking at other areas. I personally was visiting Malaysia, the Philippines and Vietnam, besides looking for other sources, looking at other manufacturing areas for us and becoming less dependent on China. But even if that's the case, for example, we're talking to a key distributor today, and he mentioned that 70% of the circuit boards that are bought in Europe come from China. So it's really a dominating position they have. And with that dominating position, you have a lot of cost pressure that they can give us. So if you do look at certain areas, can you be cost competitive? So it's almost like a two-edged sword. If you look at another area, they can't be price-sensitive, it's great that you can protect yourself from the coronavirus but can you sell the product because of the bill of materials cost? And that's what we're trying to lay out and look at everything else.

Okay, thanks very much.

Appreciate the call.

We will now take our next question from James Ricchiuti from Needham & Company. Please go ahead.

Hi. Thanks. I'm just wondering, I know it's a very fluid situation there, but what is the outlook for bringing the utilization of the four facilities in China to higher levels over the next few weeks? I assume this is mainly a case of just getting folks into the plants?

No. It's a little bit more difficult. For example, once again, people coming throughout China to everybody's factory, they have to get approval from the local town to show whether they're going back to the factory, their transportation getting to the factory. Just as important as bringing them to the factory, the government has to approve your facility, monitor the facility that you have the best hygiene practice in place. Even, for example, down to how you eat the food now at the cafeteria. You can no longer face someone in the cafeteria. You have to turn your back to them when you eat. And then a big demand that we're all facing is mask. Basically, we have currently 400,000 masks at our facility, but there's a tremendous amount of shortage throughout mask throughout the country. In China, we are required for each employee to have two masks per day. So those are the factors you have. Also, again, the logistics of Federal Express, can they come in, can they not come in. Most shipments go to Hong Kong, so there's a delay there. So overall, we're currently back at 60%. Our problem is we do have work that's currently back at 60%, but what's our output rate? Do we have any bottlenecks to bring people back from one area? So again, I just – I don't think we're going to get – probably, as we have – our goal and our objective is, China by mid-March, to get back to the 85%, 92%. And by April 1, everybody is in production and we're running back to full production. But it's a very – as I said, things can change very rapidly depending on how they control the situation. Just based on – just one more point. This is all, of course, based on no further outbreaks. And from all of our understanding, it's coming down, not going up. So we're beyond the high point.

Got it. And from a logistics standpoint, is that improving at all? Or is that also, you feel...

We're all on the same – we're all at that same 65%, 60%, ballpark we're all dealing with. Craig, do you want to add anything?

Yes. I think it's – the transportation, we're able to ship products out of our factories in Shenzhen[ph] and get a lot of those from Hong Kong. We're able to do that, but they're obviously getting it from there to the customer. It depends on the freight carriers and what their ability is to provide transport equipment, aircraft, what have you. So it's like – like we said before, it's a fluid situation, but it's getting better.

And with respect to the competitive environment, are you – is it – are there any signs that some of this business is going elsewhere? And does that damage any of the relationships longer term? Or do you see that as temporary? It sounds like most folks are in the same boat.

It's, for us, all the products, I think we're all in the same boat. I think lead times are all being stretched out by everybody. So I think, again, when lead times are stretched out, our customers and other customers are more concerned about getting availability in. So there's no way anybody would cancel orders at this time to go to a competitor. So we don't think that is our major – our major concern is getting product out the door as quick as possible to our customers.

Okay. And on the aerospace and defense side of the business, it sounds like defense, there's still a pretty healthy demand environment. And that tends to be better margin for you. How much does that help you looking out over the balance of this year?

Well, the problem is that we've been very helpful if we didn't have the Boeing situation. So again, from a margin standpoint, but again we're dealing with, again, every day, there's something new that goes on with Boeing. Yesterday, it found debris in the fuel tanks. You just don't know what's going to happen. We know we're currently on hold at this point in time, and it should be released shortly. But again, it's just a fluid situation we're dealing with. And at this point – Lynn, do you want to fill us in on what we got for Boeing?

Sure. So related to Boeing, right now, they have ceased production. We do expect that once they resume, it would be at a fraction of the rate, and there will be a gradual increase from there. We do expect a financial impact in the first half of 2020, estimated at $5 million to $6 million of lost revenue in the first half of 2020 just related to the 737 MAX. From a bottom line perspective, it's probably a couple million dollars, and that will be more heavily weighted in the first quarter. We are putting some items in place to help mitigate that cost impact that we hope to be in place in the second quarter, but things take time to put in place. We have started reducing our head count at the impacted factories and also shifting some of that labor over to the military product line that has an extended backlog to help increase our military products going out the door. So these efforts won't fully offset the impact, but we're doing everything that we can to mitigate.

Again, that is – it's not military, just aerospace. Craig, do you want to go for the margins?

Well, I think what we're saying there is we're the – by replacing some of the output, by shifting some of our production over to military products, that would help our margins by comparison to the product that we sell into the MAX. So again, we're going to have some loss margin here. We do hope we're going to be able to make some of that up by shifting our output towards the higher-margin military products.

And also, the surplus market for the connectors we build for 737s probably as well.

Yes, that's true, Dan. It's basically the longer the MAX is out of service, airlines are going to have to maintain their existing fleet. And so we participate in the aftermarket side of that where airlines or distributors would be selling the repair parts. So we should see an uptick in revenue on that side.

Got it. And last question for me is just with respect to the CUI business. It sounds like you're pleased with it, but I would assume – I would guess that you're seeing the same kind of headwinds in that business that you're seeing in other parts of the business as a result of what's going on?

This headwind is short-term because they use a lot of suppliers from China also on the short-term on that. But hopefully, they have enough inventory in place through their channels that they are protected. And they did have their largest – just to add on to that, they did have their two largest booking months in January and February for the past 12 months. So that bodes very well.

Okay. Thank you.

Thank you, Jim.

Thank you.

[Operator Instructions] We will now take our next question from Mike Morales from Walthausen & Co.

Good morning Dan, thanks for taking my question.

Good morning, Dan.

Hey Dan, been thinking about the China business and some customers look to find alternate sources outside of China. I'm curious on how you're thinking about or how you know if that business is permanently lost. I mean are you seeing customers kind of saying that even though they might be able to get sort of a better price or better quality out of Bel's products coming out of China, the value right now or for the near to medium term of diversifying the supply chain outside of China trumps that. How are you thinking about that?

I think – okay. I think, overall, I don't see – we see a major effect with the coronavirus. Where we saw a major effect is with tariffs. So we lost a key customer because of competitive loss, was able to build products in – we have one competitor that could build in the Philippines and one competitor that could build in Thailand. And that resulted in a loss going forward of $17 million. And that's why in a lot of areas – we are looking at acquisitions, and we're also looking at manufacturing bases outside of that to more of a tariff standpoint. And we also have deep concerns about the Hong Kong-China relationship, what might happen in the future under that situation. So we do want to become less dependent on China. And that's our goal for the year, to see if we can come up with different manufacturing sites. In addition to that, we do have key customers that are staying with us, that's evaluating all their products. If they find any product that is 100% built in one country, they are trying to diversify and trying to find suppliers outside there. So we do have one key customer that's working with us on possibly helping us set up a facility outside of China. And we should have a better idea about that when we report in the second quarter, so we should have a lot more visibility. So basically, overall, it hasn't hit us at that bad. But it is a concern we have, and we are looking at it. And hopefully, we will be addressing it in the second quarter.

Sure. That's helpful. And Dan, just to make sure that I heard you correctly, did you say that it was $17 million of revenue impact from the lost business shifting to other countries in the fourth quarter?

That's all the quarters.

It was – no, it wouldn't be in the fourth quarter. It's basically about $13 million on an annual basis.

All those periods.

Okay. That's helpful, thank you. Some of the commentary in the release talked about the positive trends that you guys have been seeing on the connector business and on magnetics. Can you talk about the trends that you're seeing on the orders for some of the different power products and maybe how the outlook for that is over the first half and second half of 2020?

I think with Power, we are trying to refocus. I think historically, we've been looking at the top tier customers, data center customers, the Googles, the Facebooks, the Microsofts of the world. We feel there's extreme amount of price pressure there. We probably could participate, but it's probably not coming on margins. So we're spending a lot of time focusing on – we're very strong in Europe with the Melcher brand. Also, we're very strong to the distribution channel now with CUI. So we're really focused going to more of the industrial, rail market, second-tier, third-tier markets where we feel we can offer a lot more engineering value to our customers and offer a lot more to the channel. So again, we are going through somewhat of a transition period. We still are maintaining some of our key power customers, but we are using engineering resources to go more with a broad-based insured market segment.

That's helpful. And I think lastly, maybe touching on the CUI acquisition. Maybe high level, is there anything that you feel that you can either take from CUI as far as best practices or bring from Bel to CUI in order to make the organizations run better? Or what kind of opportunities do you see to either make CUI run better or help Bel run better?

Hopefully, CUI can help us run better. But just to give you some background, we've been working with CUI for over four or five years. We have conversations to try to acquire them. We thought we had a very unique, key strategy. So where they do very well is with the e-catalog people, people like, call it, Digi-Key, Mouser that's owned by Berkshire Hathaway. And what happens in the old days, when I first started, basically, people bought products through a salesman knocking at a door, these people, either the reps that we work directly with the company or distributors that do resale. Over the past five to six years, as more and more people are using the Internet to buy their products and mostly for product development, and Digi-Key and Mouser are the key drivers for that. So instead of having a salesman talk to an engineer – engineers basically don't want to waste time with salespeople, they want to get on the Internet, buy my product quickly and put it into play. Now the best example of that is Cisco is our largest customer as you probably know. We have two direct salespeople calling on Cisco. We have two engineers with badges calling on Cisco. And then we have, I think, three rep companies calling on Cisco. And we get a fuse order from Cisco, we can't find out which one of these people sold the fuse to Cisco, and then we realize it came from Digi-Key and had nothing to do with our sales team. And that heightened – and so what we feel is, CUI is the largest power company at Digi-Key. Digi-Key is a $2 billion company. They have 600 suppliers, and they compete against Murata, Artesyn, Delta, multibillion-dollar companies, and CUI is the largest power supplier company. So we feel that we can use a lot of their best practices and e-catalog situation to really plant the seeds for Bel's future growth. In addition to that, with the CUI brand, with the Bel Fuse brand, we go from the Number 25 supplier to the Number 16 supplier. So it gives us a lot more visibility to do a lot more marketing, branding with Digi-Key than both of us have done in the past. So we just think it's just a home run opportunity. So again, we'd like to work closely with them. We have one brand that's very well suited to work with them, it's our Signal Transformer group. There's thousands of customers like CUI. And I think they – a lot of upside with both companies. Again, we did see an opportunity that we could address and CUI is trying to work with us on a high-volume product. So again, I think we're very pleased, and I think it's a tremendous growth opportunity for Bel.

Yes, those are very helpful. Thank you for taking my question. Appreciate you both.

Thank you.

[Operator Instructions] We'll now take our next question from Hendi Susanto from Gabelli Funds. Please go ahead.

Good morning, Dan, Craig and Lynn.

Hi, Hendi.

First question, can you quantify how much impact of lower productivity levels on gross margin can be?

Related to the virus?

Related to the lower productivity running at 50% to 60% and then probably it would go up to, what, like 80% to 90%? Like how should we calculate productivity level with gross margin?

That's difficult to quantify, Hendi, because like we said, we've got people returning to the factories. In many cases, if they're there and they got there and they weren't allowed to go to work, because of some of the other factors Dan talked about, we are required to continue to pay their salaries while they're there, even if they're not working. So it's kind of difficult to quantify what that impact is going to be.

Got it. And then can you share CUI's gross margin profile or relative to Bel Fuse? Bel Fuse has stated that CUI will enhance Bel Fuse's gross margin profile.

Yes, CUI will enhance it, particularly the margin profile of the power segment. They – I think we mentioned in our release, their margins are typically high 30s to low 40s, which is higher than what our typical margin are throughout the Power Group and Bel. So that definitely should show an improvement.

And Hendi, last Friday, we did file an 8-K with pro forma that included CUI for 2018 and the nine months, 9/30/2019. So that should give you an idea of their gross profit and how it improved sales results of Bel.

And then quick one, when we look into the $5.7 million of annual cost savings, does that include the $0.5 million cost savings identified at CUI?

That would not include that. And it also doesn't include the savings on the ERP system that we mentioned as well. So these would be more kind of manufacturing and overhead savings that are included in the $5.7 million.

And also I think CUI is up to 750 now, just for you to know.

Okay. And then, Dan, can you share about new product introductions that you are planning for 2020 and Bel Fuse product footprint in 5G?

Specifically, I know we're doing a lot in the RF on 5G. And we are introducing it. We do have a 5G catalog that we've introduced to the market. However, at this time, we don't see take off as fast as we've been. But all our product groups are focusing on where this is going to take us and see if we can add product to support it properly.

Okay, got it. Thank you and all the best.

Thanks, Hendi,

Thank you.

This concludes today's Q&A. I would now like to turn the call back to you.

Thank you. We appreciate your time. And hopefully, next quarter should be somewhat brighter visibility for the future. Thank you.

This concludes today's call. Thank you for your participation. You may now disconnect.